Canadian aerospace and train manufacturer Bombardier (TSX:BBD.B) has made a major bet on a new C Series aircraft, but delays and extra costs have so far left investors disappointed. Even more recently, investors were shaken again after the C Series had an engine failure during testing.
But investing is about looking forward rather than backward, and in this case, it's about what's next for Bombardier and its C Series.
Since Bombardier is a much smaller company than larger aerospace rivals Boeing (NYSE:BA) and Airbus Group (NASDAQOTH:EADSY), developing an aircraft to take on part of these companies' product lines meant betting a large portion of Bombardier's capital on the C Series. Yet at the same time, Bombardier is feeling pressure in its regional jet segment from Embraer, which is unveiling updated models that could hurt Bombardier CRJ sales or force price cuts.
The idea of creating an aircraft to take on the smaller narrowbody offerings of Boeing and Airbus has been around for several years as Bombardier looked to develop a unique product beyond its regional jet offerings. The result is the C Series aircraft, which has the newest airframe in this segment, with the Boeing 737 airframe and Airbus A320 airframe originating for the 1960s and 1980s, respectively. Of course, Boeing and Airbus have made improvements since then, but Bombardier sees an opportunity in this market by offering the latest airframe in combination with quieter, more fuel-efficient engines and increased passenger comfort.
But it's not been a smooth flight so far. The first flight of the aircraft was delayed multiple times, and the development cost exceeded initial targets. Neither is a deal-breaker, but they have both negatively affected the company by delaying the first deliveries and highlighting the possibility that Bombardier may need to raise additional capital through debt or equity.
The latest issue comes from an engine failure during ground testing of the C Series last week. Although the company believes it has found the cause and can fix it fairly quickly, the incident does serve as a reminder that there are still more hurdles to clear before deliveries can begin.
Bombardier received some disappointing news last month, as Air Canada declined to place an order for the C Series. But while Air Canada has placed an order for 61 Boeing 737MAX aircraft, these aircraft were for a different purpose in the airline's fleet. While a C Series order could still be completed in the future, Air Canada delayed the purchase of new aircraft for its small narrowbody fleet indefinitely, suggesting that such an order is years away.
There have also been concerns over an order for 40 C Series aircraft that Republic Airways Holdings (NASDAQ:RJET) placed. Because of issues relating to the size of the aircraft, the airline is seeing whether the orders can be sold to another buyer with more use for the aircraft. While it wouldn't wipe out the C Series, Republic is one of the largest customers for the aircraft, and a failure to complete the order would weaken Bombardier's order book just as it's gearing up for production.
But not all airlines are backing away from the C Series. Reuters reports that Deutsche Lufthansa met with Bombardier and showed support for the C Series program even after the engine failure. Like Republic, Deutsche Lufthansa is one of the C Series' larger customers, and support from it is critical at this point.
Bombardier's other customers also appear calm, and the engine failure hasn't caused a wave of cancellations. The company claims to have found the issue, and if it can be resolved as quickly as claimed, the problems surrounding this engine failure should blow over as flight testing continues.
From a financial perspective, Bombardier carries a higher degree of risk than Boeing or Airbus because of its smaller size and reliance on the success of the C Series. As both execution and sales risk continue to exist for the C Series, the possibility that Bombardier will need to raise additional capital remains. Without any major problems, the company looks to have enough cash and liquidity to see how the C Series sales pan out; however, the risk of a capital raise does remain present, and investors should consider the risk of share dilution or more debt.
Uncertain flight path
Through the C Series development and testing, investors' patience has also been tested as delays occurred and costs grew. With Bombardier betting over $4 billion on the C Series, success of this aircraft is critical to the company's future.
Trading at a forward P/E ratio significantly below that of Boeing and Airbus while at the same time having a larger dividend yield, Bombardier has a lower valuation because of greater investment risk than its larger rivals. This differing amount of risk and reward allows investors to decide for themselves whether they want the diverse product line and larger size of Boeing and Airbus or the greater potential for upside and lower current valuation of Bombardier.
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Alexander MacLennan owns shares of Air Canada. The Motley Fool recommends Embraer. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.